Standing Committee A

[Mr. Edward O'Harain the Chair]
(Except clauses 13 to 15, 26, 61, 91 and 106, schedule 14, and new clauses relating to the effect of provisions of the Bill on section 18 of the Inheritance Tax Act 1984)

Schedule 9

Leases of plant or machinery: miscellaneous amendments

Amendment proposed [25 May]: No. 165, in page 260 [Vol I], leave out lines 17 to 31—(Mrs. Villiers.)

Question again proposed, That the amendment be made.

Edward O'Hara: I remind the Committee that with this we are discussing Government amendment No. 119.

Theresa Villiers: I wish to emphasise that professional associations continue to be worried about several aspects of the schedules that we examined before the recess. Indeed, subsequent to our debate, the Finance and Leasing Association wrote to the Minister about its continued concern at the loss of the tax break for leased environmentally friendly equipment. It repeated its invitation to work with the Government to ensure that the proposal worked productively to help the urgent need to tackle climate change. It also emphasised its support for the worries that I expressed about earlier amendments in respect of the breadth of the terminology used for the motivation for tax avoidance and the change of wording that has been adopted by the Government to switch, as the Law Society said, to the formulation that it would be sufficient to prove that it was reasonable in all circumstances to believe that tax avoidance is the motivation for a transaction. In the light of that and our earlier discussions, I ask the Committee to press the amendment to a Division.

Question put, That the amendment be made:—

The Committee divided: Ayes 10, Noes 16.

Question accordingly negatived.

Amendment made: No. 119, in Â lineÂ 3Â [VolÂ I],Â after ‘treated' insert ‘by that person'—[John Healey.]

Question proposed, That this schedule, as amended, be the Ninth schedule to the Bill.

Theresa Villiers: The Committee may or may not recall the worries that I expressed about tonnage tax companies in the debate on amendment No. 185 and the proposed new paragraph 91B of schedule 22 to the Finance Act 2000 that it would introduce. Similar concerns apply to proposed new paragraphs 91B, 91C and 91E of schedule 22 to the Finance Act 2000. On proposed new paragraph 91B, concern has been expressed that the requirement of a direct relationship between a tonnage tax company and a lessor is unduly restrictive. Will the Financial Secretary confirm whether any sub-leasing will still be permitted under the framework set out in the schedule? I have been informed that restrictions on sub-leasing will make it much more difficult to syndicate leasing transactions related to tonnage tax companies, and the inability to split risk via syndication can be expected to reduce the availability of finance to such companies. I am told that there have been avoidance problems in the case of sub-leases, but I hope that the Revenue will find a way to interpret the new paragraph in such a way as not to disrupt genuine non-tax related syndication, an aim that is an important part of the way in which the tonnage tax regime has worked to date.
Proposed new paragraph 91C provides that the exception to the new rules for tonnage tax companies will apply only to a company that remains responsible for the operation of a ship and for defraying substantially all voyage-related expenses. The solicitors Norton Rose, to whom I am grateful for providing a briefing, point out that to fall within the tonnage tax regime in the first place a company must have strategic and commercial management of a vessel. The degree to which sub-contracting can take place is thus already limited. Norton Rose is concerned that further restriction is not necessary and could be damaging to the success of the regime. We must bear in mind that the UK is a reasonably high-cost environment for the shipping industry, so we must make every effort to make it as competitive as possible if the Government’s tonnage tax regime is to have the success that they wish.
Proposed new paragraph 91E is on anti-avoidance, and there is anxiety that it is drafted very widely and could act as a deterrent to the new regime. Will the Financial Secretary outline some of the avoidance schemes that the paragraph is designed to target? I highlight comments made by Louise Higginbottom, the somewhat outspoken shipping lawyer to whom I referred shortly before the recess. She pointed out that the anti-avoidance provisions were so widely drafted that they would cause a crisis of confidence and uncertainty all round.
One further general point should be considered on the interaction of the new leasing framework and tonnage tax companies. I gather that representations are being made to HMRC that existing restrictions on the security that a lessor can receive on a tonnage tax lease are overly restrictive and could inhibit refinancing initiatives that do not have a tax motivation.
I am confident that the Financial Secretary aspires to maintaining a competitive tonnage tax regime, so I hope that he can reassure me and the Committee on the points that I have made.

John Healey: I welcome you back to the Chair, Mr. O’Hara.
In her broad comments on the schedule, the hon. Member for Chipping Barnet (Mrs. Villiers) doubled back to the earlier debates that we had on shipping and the relation of the new provisions to the tonnage tax regime. Before answering her specific questions, I shall remind her and the Committee of the specifics of tonnage tax and the principles that underpin it. It is, of course, an extremely generous regime, introduced by this Government to support the shipping industry. Leasing benefits and tonnage tax companies have always been a difficult area. Although the hon. Lady did not say so, I think that she would recognise that. If she re-examines the work of Lord Alexander, which helped us to lay the groundwork for the introduction of the tonnage tax, she will see that he recognised the difficulty of the matter.
There have always been anti-avoidance rules on leasing and tonnage tax, and arrangements have always been developed in and around the industry to try to sidestep them. Shipping has not only a special form of support in the tonnage tax but a special carve-out within the proposed leasing rules and regime, as I have previously explained. That carve-out will apply only if the three principal conditions that we examined are met.
The short answer to the hon. Lady’s specific question about sub-leases is no. Sub-leases will not be allowed under the legislation. Syndication might be possible, and we will examine that with the industry. On the question of anti-avoidance, the expert adviser’s opinion that she cited, which suggested that some of the arrangements would cause a crisis of confidence in the industry, is far from the mark. It is a huge overstatement that does not do a great deal to help sober and proper debate on the subject.
Schedule 9 completes the legislation for the new and improved structure for taxation of leases of plant or machinery. First, it will create a regime that meets the four principal objectives that we established to deal with the long-standing distortion in the tax system that has driven business decisions on long-term finance. Secondly, it will open up opportunities for overseas leasing from the UK. Thirdly, it will create a sounder structure for the taxation of leasing in future. Finally, it will remove any uncertainty about the compatibility of UK leasing rules with those of the European Union.
The Government have recognised the importance of the leasing industry to UK business and the UK economy. We have consulted with industry interests and discussed in detail the specifics of the regime. At all stages, we have sought to minimise the potential negative impacts of the new regime and particularly to ensure that the rules are framed in a fair way that will minimise impact on small firms. It has not been easy, but I believe that the set of clauses and supporting schedules set out a sound regime for the future. I hope that the Committee will back schedule 9.

Question put and agreed to.

Schedule 9, as amended, agreed to.

Clause 82 ordered to stand part of the Bill.

Schedule 10

Sale etc of lessor companies etc

John Healey: I beg to move amendment No. 215, in page 19, line 25 [Vol II], leave out sub-paragraph (2) and insert—
‘(2) No person is to be treated as receiving an amount of income, or as incurring an expense, as a result of any provision of this Schedule in so far as the income or expense arises by reference to the relevant plant or machinery subject to a lease which is disposed of.
(2A) If, as a result of sub-paragraph (2), no income is treated as received by a company, no accounting period of the company ends or begins as a result of any provision of this Schedule.
(2B) In relation to any disposal made before 2nd June 2006— 
(a) sub-paragraph (2) applies as if the words from “in so far as” to the end were omitted, and
(b) sub-paragraph (2A) applies as if the words from “If” to “a company,” and the words “of the company” were omitted.'.
The amendment corrects a defect in the drafting of paragraph 40 of schedule 10. At this point, it might help the Committee if I say a little bit, but not too much, about schedule 10. I see a chuckle of approval from the Government Whip at the suggestion that I should introduce the schedule without going into it at great length.
The schedule deals with transactions resulting in a loss of tax when a lessor company changes hands. It also covers situations in which a company carries on a leasing business in partnership and the company’s interest in the partnership decreases. Tax has been lost because groups have taken advantage of capital allowances to reduce the profits of a lessor company in the early years of a leasing transaction. The lessor company is then sold to a loss-making group when the leasing transaction is about to become tax profitable or the lease is about to terminate. The sale of a company to a loss-making group turns an acceptable tax deferral into an unacceptable permanent tax deferral or sheltering.
I am sad to say that the practice has become widespread. It is widely recognised that action is necessary to deter such behaviour while ensuring that sales, when they are bona fide commercial transactions, between profit-making groups of lessor companies are not deterred. The schedule achieves that. The leasing industry has been expecting action to prevent such tax loss, and the Government acted on 5 November 2005 in the pre-Budget report with the introduction of draft legislation. That measure was brought into effect immediately with that announcement.
As I said, the amendment relates to paragraph 40, which applies if a company sells an asset subject to a lease and retains a part of the lease income stream on the same day as the company itself changes hands. The paragraph is intended to deal with an unusual pattern of events, but as it stands goes too far and makes schedule 10 ineffective when schedule 228K to the Capital Allowances Act 2001 has effect on the same date. It therefore gives an unfair advantage to companies that find themselves in such an unusual situation, and also opens up the opportunity for other companies to contrive such a situation in order to prevent the schedule from having effect. The amendment will close off that opportunity.
In summary, the schedule, with the amendment, is necessary. It has been expected. It was announced at the pre-Budget report and will prevent ongoing tax losses, such as the £35 million lost this year. The changes are therefore timely and appropriate, and I hope that the Committee will back the amendment.

Amendment agreed to.

Question proposed, That this schedule, as amended, be the Tenth schedule to the Bill.

Theresa Villiers: I shall not detain the Committee for long. I agree with the Financial Secretary that there is a genuine problem to be tackled, although certainly it would have been desirable if a way could have been found to have done so more simply. However, he and I are at one in saying that the situation as it is leads to revenue loss and therefore that action is needed to deal with it.
I shall raise two or three points about the impact of schedule 10 and how it will operate in practice. I understand that there were initial discussions as to whether a motivation test could be incorporated into the schedule, but that it proved difficult to draft. Some anxiety has been expressed therefore that certain transactions that are not tax related could be affected by the new charge. In particular, I would be grateful to hear the Financial Secretary’s comments on whether that could have an impact on takeovers of companies with leasing operations, such as banks.
I gather that Revenue and Customs indicated that in such a case a purchaser should receive a corresponding tax benefit to offset any problems caused by schedule 10, but the circumstances of the purchaser might be different from those of the vendor and the relief not capable of being used. I welcome the Financial Secretary’s assurance that schedule 10 is not capable of operating effectively as a poison pill where there is an attempt to take over a bank with a leasing operation.
I received the useful briefing from the Chartered Institute of Taxation which asserted on another point that,
“the provisions go further than dealing with the perceived mischief at which they were aimed. The provisions will not simply prevent the acquiring company or group from setting off losses against profits attributable to the reversal of the timing difference, but will impose a penal tax charge on a deemed disposal of assets. This charge will effectively reverse the intended effects of the capital allowances system in relation to the lessor.”
Again, I should be grateful if the Financial Secretary addressed the concerns expressed there, and the suggestion that a more effective way of dealing with the problem at which schedule 10 is aimed would be to provide that post-acquisition profits attributable to the reversal of the timing difference should not be available for group relief in the acquiring group.
On the rest of the schedule, I welcome a number of points that have emerged from what the Financial Secretary described as a very lengthy consultation process. A welcome change since the initial draft of schedule 10 is that companies that lease what is primarily real property, although it contains an element of plant and machinery, are not included in the schedule 10 regime. As hon. Members will recall, that is consistent with schedules 8 and 9. That will be particularly important in relation to private finance initiative projects in which the main item leased is land and buildings.
A concern was expressed in relation to intra-group transfers, and I welcome paragraph 13. In response to other concerns expressed during the consultation, the Government have made it clear that where a qualifying change of ownership occurs as a consequence of the internal reorganisation of a group of companies, no charge will be triggered so long as all the companies involved remain 75 per cent. subsidiaries of the principal company. That should alleviate concerns that the charge might be triggered merely by the internal restructuring of a group. However, there is a concern that the exemption contained in paragraph 13 has not been extended to the situations covered by paragraph 23, which concerns the transfer of interest in partnerships. Just as corporate groups might be internally restructured, the internal restructuring of partnerships is also a relatively common practice. It would be welcome if the Government were to consider whether a paragraph 13-type savings provision might also be necessary in the paragraph 23 context of partnerships.
Finally, a number of people who are concerned about schedule 10 have pressed me to seek one further point of clarification. It relates to sub-paragraph (2) of paragraph 23, which deals with tax relief to new partners. For example, if there are three partners, A, B and C, and C sells its share in the partnership to D, does the relief set out in paragraph 23 go to the incoming partner, D, alone, the existing partners or the existing partners and the incoming partner? I should be grateful if the Financial Secretary gave me an indication as to how paragraph 23(2) will work in that context.

John Healey: I welcome the general welcome that the hon. Member for Chipping Barnet has offered to the schedule. As she said, it is relatively complex. To be effective, the legislation must anticipate the inevitable tax planning developments that would take place to avoid a simple charge on the outright sale of a lessor company. That might involve—in our experience it often does—complex arrangements such as the useof consortia or partnership structures, and the fragmentation of the leasing business. Any company that chooses to stray into such complex fields will do so deliberately. It will almost certainly do so on the basis of sophisticated advice that it has received as part of the tax planning process. It is reasonable to argue, therefore, that it must accept that the legislative remedies must also be sophisticated in order for the legislation to meet its objectives and to deal with such situations.
The hon. Lady asked me about the effect on the sales of lessor companies. The measure does affect all sales of lessor companies, but will have a significant tax effect only when the sale is to a loss maker. That means that it targets the transactions that the Government want to deter.
It may help the Committee and the hon. Lady if I explain in general terms the way in which the charge works on the sale to a loss-making company. It is designed to pull back the timing advantage given through the capital allowances and taken by the selling group through access to losses. It was never intended that that timing difference would be permanent. The measure deals with situations in which the transaction would have the effect of turning a tax-timing advantage into a permanent deferral. That is the underlying principle and purpose of the legislation and the way in which it works.
The hon. Lady was also concerned about the potential for modest or trivial changes in partnership arrangements to trigger this complex process. In our analysis and judgment of the discussion we had with the industry, it is clear that leasing business is typically carried on by companies that are 100 per cent. subsidiaries and that sales are typically 100 per cent. sales. Where a business is carried on by a company owned by a consortium, the relationships typically remain constant. Where a business is carried on by companies in partnership, their interests in the business usually remain constant. It is therefore unlikely that there will be numerous small changes that would trigger the charges that the provision and the legislation make.
Once again, the schedule must deal with partial sales to ensure that it is not possible to sell a lessor company in a piecemeal fashion and thereby escape the charge. Therefore, there are provisions in the legislation that deal proportionately with such changes in holdings. I hope that those points of explanation allow the hon. Lady and her colleagues to accept the schedule.

Question put and agreed to.

Schedule 10, as amended, agreed to.

Clause 83 ordered to stand part of the Bill.

Clause 84

Disposal of plant or machinery subject to lease where income retained

John Healey: I beg to move amendment No. 96, in clause 84, page 79, line 18 [Vol I], leave out from first ‘the' to ‘all' in line 19 and insert
‘lessor remains entitled immediately after the disposal to some or'.

Edward O'Hara: With this it will be convenient to discuss Government amendment No. 97.

John Healey: As the Government have tabled two amendments to the clause, I ought to explain the purpose of the clause and the amendments.
As with clauses 83 and 82, clause 84 is part of a range of measures designed to prevent companies from arranging their affairs in such a way that losses from a leasing business are fully utilised while the profits fall out of tax. The clause as drafted deals with the separation of a leased asset from its lease by the company selling the asset and keeping all or some of the income from the lease. It has been used as the first step in an arrangement that shelters the training company from taxation, usually by taking the lessor company offshore.
The measure in clause 84 was published in draft form in the pre-Budget report. A number of changes were made to the draft legislation introduced then to ensure that it operates fairly. Government amendmentsNos. 96 and 97 are a response to further recommendations. They ensure that clause 84 of the Bill operates appropriately when a lessor sells part or all of the income stream from a leased asset and then sells the asset. I commend the amendments and the clause to the Committee.

Amendment agreed to.

Amendment made: No. 97, in clause 84, page 79,line 37 [Vol I], leave out from second ‘the' to end of line 38 and insert
‘lessor remains entitled immediately after the disposal'.—[John Healey.]

Clause 84, as amended, ordered to stand part of the Bill.

Clause 85 ordered to stand part of the Bill.

Clause 86

Insurance companies

Question proposed, That the clause stand part ofthe Bill.

Edward Balls: I welcome you to the Chair again, Mr. O’Hara.
Clause 86 introduces schedule 11, which contains a series of measures dealing with the taxation of life insurance companies. They provide a rule for inherited estate assets pending the outcome of consultation; protect the tax base where there is demutualisation and when investment profits are not recognised by a non with-profits company and they prevent unintended tax charges on a transfer of business.

Celia Barlow: I welcome the new clause, which introduces schedule 11. The measures have been taken to counter tax avoidance in life insurance schemes—for example, taxing a possible surplus after a demutualisation and in other cases.
As the life insurance market is in flux it is a very good time to iron out tax problems that arise after the transfer of business. I am sure that many hon. Members sometimes have difficulties, as I have, in understanding the details of their own life insurance policy, and it sends out a reassuring signal to all policy holders that their financial position will not suffer if their insurer is taken over by another company, for example, or in the case of demutualisation.
I commend the Government on their constructive approach to the matter, having spoken to all relevant players in the industry, which after initial resistance has brought about a consensus in a difficult and complex area. It is no wonder that the Association of British Insurers has therefore welcomed all the propositions.

Edward O'Hara: Order. The hon. Lady is speaking to clause 86 stand part of the Bill. Clause 86 is a hollow clause, which introduces schedule 11. Her substantive remarks should perhaps be reserved for the debate on schedule 11.

Celia Barlow: I stand corrected, Mr. O’Hara. I shall speak later in the debate.

Question put and agreed to.

Clause 86 ordered to stand part of the Bill.

Schedule 11

Insurance companies

Mark Hoban: I beg to move amendment No. 170, in page 22, line 3 [Vol II], leave out from beginning to end of line 16.

Edward O'Hara: With this it will be convenient to discuss amendment No. 171, in page 22 [Vol II], leave out lines 8 to 16 and insert—
‘(2) Accordingly, in section 432A of ICTA 1988 insubsection (5) (power to extend orders under subsection (3) in relation to periods of account ending before 1st October 2007), substitute “1st October 2006” with “1st October 2007”.'.

Mark Hoban: I, too, Mr. O’Hara, add my welcome to those of my hon. Friend the Member for Chipping Barnet (Mrs. Villiers), the Economic Secretary, and the hon. Member for Hove (Ms Barlow).
Before I comment on the two amendments I want to make a general point about the amendments we are tabling to schedule 11 and perhaps echo the point made by the hon. Member for Hove on clause 86. These are probing amendments and I do not intend to press them to a Division, but they give us the opportunity to understand the reasoning on which HMRC and the industry, as represented by the ABI, reached a consensus on schedule 11. Clearly, there were a great many discussions between the ABI and HMRC and their consensus demonstrates how effective consultation can be in shaping legislation. As an aside, I say that the most contentious areas are those on which there has been the least consultation.
Paragraph 1 of the schedule would make permanent the provisions of S.I. 2005/3465, which came into force on 6 January 2006 and which modified sections 432A and 432B of the Income and Corporation Taxes Act 1988. The purpose of the statutory instrument as stated in the explanatory memorandum was
“to ensure that...income and gains from certain assets of the company which are in excess of the regulatory solvency and other requirements of the company are not treated as referable to categories of business the income and gains of which are exempt from tax but to basic life assurance and general annuity business”.
I shall return to basic life assurance general annuities business later on. The memorandum continues:
“Where any income or gains are so treated, an adjustment is made to computation of profit from the exempt categories of business to prevent double counting.”
I think that there is agreement on the nature of the statutory instrument, but originally it was subject to a sunset clause, as agreed during the Committee stage of the Finance (No. 2) Bill last year. As a result of representations made at the Committee stage and on Report, the Government pledged to introduce changes through primary legislation. However, although it is a rare occurrence for the Opposition to chide the Government for keeping a promise, will the Minister explain why the Government have introduced primary legislation on the matter when, as we shall discuss shortly, there is extensive ongoing consultation between HMRC and the industry on the future taxation of life assurance business?

Edward Balls: I welcome the comments of the hon. Member for Fareham (Mr. Hoban) and of my hon. Friend the Member for Hove, who referred to an ABI briefing note of which I have a copy. The briefing is consistent with what the hon. Gentleman said, in that it describes the consultation that has taken place on the issues over recent months, and concludes:
“Whilst we recognise that amendments 170 to 183 provide opportunity for debate on this issue, we ask that the Committee support clause 86 and maintain it in its current form within the Bill.”
Clearly, therefore, the consultation has been effective and there is now an opportunity to set out the issues and explain the current position.
Those Members who served on the Committee that examined last year’s Finance (No. 2) Bill will remember the debate on the regulation-making power and the sunset clause. As I recall, it was most memorable for the lengthy lesson in procedure given by the Chairman and Opposition Members to the hon. Member for Eastleigh (Chris Huhne), who unfortunately cannot be here today, but who made a number of contributions, not all of them truncated. Rather than dwell on the past, however, I shall reflect on the lessons that we have all learned over the last year in arriving at this year’s Finance Bill.
Last year’s Bill was an interlude in a process that began with the pre-Budget report 2004. There was an announcement at that time that regulations would shortly be laid to change the tax treatment of incomes and gains of a life company’s inherited estates; inherited estates being assets built up in a company over time which are not needed to pay policy holders. The insurance industry had known for some time that the Government were unhappy about the way in which companies with inherited estates could use the existing rules. Indeed, my predecessor read an extract from a court judgment about an insurance business transfer in 2000, in which the company concerned said that it expected the loophole to be closed, so insurers were aware of the Government’s need to act. Paragraph 1 of schedule 11, which concerns inherited estate income, is a key step in a principled reform of the tax treatment of income from inherited estate assets in particular, and of income and gains from assets in general.
After the pre-Budget report of 2004, the industry’s observation was not that the principle of acting was wrong, but that it needed a longer consultation time, so the draft regulations were withdrawn and consultation occurred in order that legislation could be introduced in the Finance Bill 2005.
It is fair to say, as the hon. Member for Fareham hinted at, that there was desire throughout the process to ensure that the provision occurred in primary legislation with full scrutiny. There were intensive consultations and discussions. However, in the spring of 2005, it became clear that it would not be possible to get all the detail sorted out in the Finance Bill 2005. It was therefore agreed with the industry that it would be better to get the measures right rather than to move quickly. In that memorable Finance Bill 2005, we introduced a regulation-making power but made clear that it would only operate for a limited period, the so-called sunset clause to which the hon. Gentleman referred. Any longer term changes to the treatment of life company apportionments would have to be included in primary legislation and subject to full parliamentary scrutiny.
Since last year’s discussions on the Bill, as the ABI note makes clear, there have been further extensive consultations. Last December, we reached a point when an order was laid giving the new rules for inherited estate to 2005 only. As discussions were not complete, a further amending order was laid on 19 May, which still only applied to 2005, as required by the sunset clause.
As the hon. Gentleman said, one of the first decisions I made as a new Treasury Minister was to approve the consultation document for publication. That is now informing discussions with the industry about a broader reform of life insurance taxation. As those who listened to the debate last year will appreciate, that is a complex area to understand. I emphasise that we are not intending to overhaul the entire life insurance tax rules. The consultation document on 16 May covered a number of issues, including apportionments. It included some draft clauses for discussion. Our intention is to look at responses in the autumn and to come forward with changes to next year’s Finance Bill across the wider piece.
However, if we have a sunset clause which ends at the end of 2005 and we are now consulting on changes for next year, we have an issue about 2006 because the sunset clause meant that the regulations only applied to 2005. We could have decided to use existing powers to extend the regulations by a further year—to postpone the sunset. However, that would not have been in the spirit of the use of the sunset clause. Instead, we decided that it was right to have open scrutiny in the Bill on the measures that we are setting out for this year, but fully in the knowledge that we are also consulting on measures for next year’s Bill, which will take forward the process for the longer term.
I hope that members of the Committee will appreciate that we have tried to use primary legislation to ensure that there is proper debate in Committee rather than that happening through an extension of regulations. However, it is not a permanent extension. It is not our intention to leave the rules in place in the medium term. Instead, the current consultation will continue so that we can come back with further and more thorough reform, with the apportionment rules for the 2007 Finance Bill.
Amendment No. 170 would return to the state of affairs that existed before 2005. It is clear that that is not an acceptable position. That is why we acted in the first place. In last year’s Finance Bill debate, that was accepted by both sides of the House. The hon. Member for Runnymede and Weybridge (Mr. Hammond) said:
“We accept that there is scope for tax avoidance where genuinely surplus funds are allowed to roll up at a lower rate of deduction and then potentially transferred out to the benefit of shareholders at a later date.”—[Official Report, 7 June 2005;Vol. 434, c. 1145.]
It was accepted on both sides of the House that we needed to act, possibly by the hon. Member for Eastleigh as well, but he did not always get a chance to make his point. An amendment that seeks to go back to the status quo ante and take away the powers we introduced for 2005 and seek to now apply them to 2006, would be a backward step. Therefore, I encourage the Committee to reject the amendment.
Amendment No. 171 would limit the extension of the effects of the orders just for one year to reflect in primary legislation the effect of extending the regulations by a year. I have to make it clear that I have substantial sympathy with that view. It is not our intention for this legislation to sit for more than a year. That is our best hope. As I said, we are actively consulting at the moment. Our judgment is that although that consultation is going on, we cannot guarantee that this matter can be sorted out for next year. We have already seen, from the consultation over the past year, that these things take time to get right. As the hon. Member for Fareham said, the fact that the consultation has been carefully done and is iterative with the industry means that we are now getting things right. For that reason, we decided that it was better to legislate in the Finance Bill, rather than have effectively only a one-year extension, under amendment No. 171. I urge the Committee to reject both amendments.

Mark Hoban: I thank the Economic Secretary for his response to amendments Nos. 170 and 171. I understand his commitment to seeing through the consultation process and doing all that he can to achieve the changes to the taxation of life assurance business in the 2007 Finance Bill. Given the positive remarks that he made about that consultation, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Mark Hoban: I beg to move amendment No. 193, in page 22, line 30 [Vol II], at end insert—
‘2A (1) Sections 439B and 441 ICTA 1988 shall cease to have effect and section 436 shall be amended by substituting “Gross Roll-up Business” for “Pension Business” in each place that it occurs.
(2) “Gross Roll-up Business” means all long-term business written other than Basic Life Assurance, General Annuity Business and Permanent Health Insurance.'.
The amendment strikes to the heart of one of the aspects in the consultation document that the Economic Secretary mentioned earlier. Perhaps it would help if I gave the Committee some background to the taxation of life assurance, to assist in its understanding the reasoning behind the amendment. I suspect that this is a slightly esoteric issue, but any hon. Members wishing to understand taxation of the life assurance industry would find that their time would be well spent looking at the consultation document, which gives clear background on why we are where we are now and acts on the proposals about which the Government are consulting.
The principal stream of business tax under life assurance rules is abbreviated to BLAGAB—basic life assurance general annuities business—and is subject to the I minus E basis of assessment that considers the income and expenditure on that business. One feature of the I minus E basis, with which I should like to deal now because it recurs later in other amendments, is that the gains made on investments on behalf of policy holders are taxed as they arise. If it were only BLAGAB, that would not be a problem, but the problem faced by the life assurance business is that there are different rules on taxation for six other streams of life assurance business grouped and known as non-BLAGAB: pensions business, life reinsurance business, overseas life assurance business, individual savings account business, the child trust fund and other long-term business that is not life assurance. That final category principally covers permanent health insurance, but it also contains other lines of business. It is clear, from that list of non-BLAGAB businesses, that the different streams have arisen as circumstances have changed, so with the introduction of individual savings accounts and the child trust fund, within some businesses, insurance policies linked to those two products require separate taxation consideration.
The main categories of non-BLAGAB business are taxed in line with case 1, schedule D, although with specific rules for insurance companies, whereas permanent health insurance is taxed differently, on a basis that is comparable with general insurance.
The amendment recognises that there are similarities between the streams of non-BLAGAB business, and that it would therefore be easier if they were merged. In the consultation document, the industry calls such business gross roll-up business. There seems to be a degree of consensus within the industry that the streams of business need to be rationalised, and given the complexity of the matter even a layman can see why that would be beneficial. The consultation document holds out the tantalising prospect of a reduction in the number of pages of legislation. Paragraph 3.23 of the document states that the move from six classes of business to one would require the addition of six pages of law and four pages of transitional provisions, but the removal of 20 pages. Those of us who are lucky enough to serve on the Committee considering the 2007 Finance Bill will see whether that tantalising prospect comes to fruition.
One of the areas of debate mentioned in the consultation document and highlighted by the amendment is whether gross roll-up business should include permanent health insurance. The amendment is intended to probe the Government’s thinking on why it should remain outside gross roll-up business. That is a matter for the Treasury and the industry to decide through consultation rather than something that we should vote upon in Committee.
The industry has a number of concerns about the inclusion of permanent health insurance in gross roll-up. The first is on the treatment of dividends and the inclusion in the investment return on gross roll-up business of all dividends from UK companies. It might strike the Committee as a perfectly reasonable move, but the dividends are currently excluded because permanent health insurance is taxed on the same basis as general insurance for which dividends are taxed. If permanent health insurance is brought within the definition of gross roll-up business and the dividends are taxed, there will presumably be an impact on the pricing of permanent health insurance policies. The price will have to reflect the tax that will be charged. Will the Economic Secretary advise us on what modelling is happening within the Department to assess the consequences for the price of permanent health insurance of a change in the tax treatment of dividends earned on such business?

Rob Marris: I am not certain that I am following what the hon. Gentleman says. Will he go back a couple of sentences? I appreciate that this is a probing amendment, but does it suggest that permanent health insurance should have a different tax regime from that which he proposes for everything else, to keep down the cost of premiums?

Mark Hoban: I am grateful to the hon. Gentleman. I saw from the quizzical expression on his face that he might probe me on the matter. At the moment, as I understand it, dividends received on shares held in a pool of assets supporting permanent health insurance are not taxed, in line with other general business. If permanent health insurance is incorporated in gross roll-up business, those dividends will be taxed. Hon. Members might say, “Well, we would then be entitled to look at all other types of life assurance-type business with dividends that are taxed,” but there is clearly an economic consequence of taxing the dividends in question, as it may well force up the price of permanent health insurance. The appropriateness of that is a matter of debate for the Treasury and the industry, but one of my concerns is that a change in the pricing structure could make it less attractive for people to take out permanent health insurance, putting them and their families at risk if they suffer health problems.
The second matter raised by the industry is the loss of flexibility in the use of losses. Losses in permanent health insurance are currently carried forward, set off sideways against the shareholders’ share of BLAGAB profits, or carried backwards. The industry’s concern is that if permanent health insurance were to be included in non-BLAGAB business, it might limit the ability to offset losses on permanent health insurance business against BLAGAB profits, as can currently be done.
The Economic Secretary indicated that he hoped that the consultation would be concluded by this autumn with a view to including measures in the 2007 Finance Bill. Does he anticipate a further circulation of draft clauses prior to their inclusion in that Bill?
A number of discussions and disagreements about the interpretation of legislation have taken place at different stages between the industry and the Treasury. I shall return to that point when I discuss a later amendment. Given that long-term planning is involved, if significant changes are proposed beyond those set out in the consultation document, further consultation with the industry would be beneficial to ensure that the spirit of consensus achieved by the Government on the present changes continues.

Edward Balls: As the hon. Member for Fareham said, we are in the early stages of a new consultation process following the publication of the consultation document on 16 May. It is fair to say that there is consensus in the Government and across the industry that a further round of consultation is a good idea. The Association of British Insurers says in its briefing note that it looks forward to being fully involved in the consultation and to having the opportunity to consider legislation further.
There is a consensus on the need for action and consultation, but we are at far too early a stage for any consensus within the industry, let alone between industry and the Government, about what form changes should take. We are holding a consultation to examine precisely those matters. We have set up a series of working groups to consider the issue between now and the end of September, and once we have received their feedback, we will know what steps to take next.
One of the major issues covered in the consultation and the consultation document is the question of amalgamating a whole load of different business categories into a single category. The general view is that amalgamation is a good thing, but there are two different ways that it can be done, as the consultation document makes clear with the pros and cons of each way. The consultation process will take and consider industry views on which of those two approaches would be better. Amendment No. 193 would effectively pre-empt that consultation by choosing one of the two options. More than that, it proposes one amendment to one clause, whereas our consultation document published consultation on 20 clauses to try to achieve our desired outcomes. The issue is much more complex than the amendment allows.
Amendment No. 193 would pre-empt our consultation with the industry. I assure the hon. Gentleman that it will be done properly. The Government intend to publish a further set of draft clauses following that consultation, at or around the time of the pre-Budget report. I also assure him that the issue of permanent private health insurance will be covered in that consultation, but it is too early to comment on the outcome. The Committee will note the interest that the hon. Gentleman has taken in private medical insurance.

Mark Hoban: It is not private health insurance but permanent health insurance, which is altogether a different product.

Edward Balls: I understood the hon. Gentleman to be talking about permanent private health insurance.

Mark Hoban: To clarify, PHI is permanent health insurance. It has nothing to do with BUPA or PPP. It provides cover for those who are unable to work in the event of a serious accident or illness. It is a form of income protection policy rather than the choice to go to a Nuffield hospital or somewhere similar for an operation.

Edward Balls: I am grateful to the hon. Gentleman for that clarification. I was about to note his interest in the issue. I remember the frustration of the hon. Member for Eastleigh during the debate last year about the fact that he was unable to propose amendments to the Finance Bill that would have an Exchequer cost. That was why, in the end, his points were ruled out of order by the Chair. I can see the hon. Member for Fareham champing at the bit to make proposals, but because he understands the procedure very well he will not be doing so. I ask him therefore simply to withdraw the amendment.

Mark Hoban: I wish at times that my neighbour, the hon. Member for Eastleigh, were here to defend himself in person. I am sure that one of his colleagues will leap to his defence at some point even if their remarks are truncated.
I must chide the Economic Secretary for being slightly more obsessed with settling old scores with the hon. Member for Eastleigh than with tackling the point of the amendment. It has nothing to do with giving the Exchequer tax-raising powers, but with understanding the structure of life assurance business and its taxation. Perhaps, he and the hon. Member for Eastleigh will consider our conversations somewhere else—without their jackets, maybe—rather than involving the Committee.

Edward Balls: I should like to clarify the situation for the hon. Gentleman. I was on the Back Benches and I had no dispute with the hon. Member for Eastleigh who at that time, as we all were, was learning the processes of the Committee: what we were allowed to do and when we were allowed to speak, and the fact that we were unable to make the kind of amendments that he was attempting to make because they would have had tax and spending implications. I noted only that the hon. Member for Fareham has a particular interest in such areas, but obviously it is not for him to make such amendments today.

Edward O'Hara: We shall call that clarification.

Mark Hoban: I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Mark Hoban: I beg to move amendment No. 172, in schedule 11, page 29, line 30 [Vol II], leave out from beginning to end of line 41 on page 30.
I promise to make no reference whatever to other Committee members who have served in previous years on the Finance Bill.

Edward O'Hara: Order. Great minds are thinking alike; a little less reference to the past might be in order.

Mark Hoban: That is a salutary warning to us all.
Amendment No. 172 is a probing one. Paragraph 5 of schedule 11 addresses the taxation of surpluses arising when mutuals seek to demutualise. As indicated by the explanatory notes, it seeks to prevent companies from using surpluses that arise prior to demutualisation and using those surpluses to prevent tax rising in the future by reducing taxable profits in the post-mutualisation period. Those measures were announced on 29 September 2005, have been consulted upon, and form part of the consensus between the Association of British Insurers and Her Majesty’s Revenue and Customs.
I understand and believe that most of paragraph 5 is right and is the result of the consultation process, but will the Economic Secretary put on the recordthe reason behind proposed new section 444AK of the Income and Corporation Taxes Act 1988, which the amendment seeks to remove? That proposed new section levies an additional charge if there is a reduction in the unappropriated surplus below the amount as at 31 December 2002. The notes indicate that that applies to a mutual that, prior to demutualization, seeks to increase the unappropriated surplus and then decrease it post-demutualisation, creating a tax reduction. Arguably, given that it is a mutual, there would be no reason for it to create a surplus as there is no profit attributable to shareholders. Typically, mutuals tend to break even for tax purposes, or even suffer a slight loss due to some relatively small adjustments. Therefore, it would seem odd, at first glance, to introduce new section 444AK.
The measure is also one sided in that there is no provision to create a tax deduction when an unappropriated surplus is increased. That lack of symmetry has caused a degree of concern, and I should be grateful if the Economic Secretary would comment on that.

Edward Balls: I shall clarify the position and then respond to the amendment. The measure will affect not just one demutualisation, nor is it aimed at just one company. In the past few years, there have been a number of demutualisations and transfers of business between insurance companies in different circumstances. While those have been instigated for commercial reasons, companies carrying out demutualisations or transfers of business occasionally use them as opportunities for tax avoidance, potentially on a large scale, which the Government have prevented in the last three years’ Finance Acts. We have done so in this one, too. We see no reason to offer former mutual companies the advantages that arise when, on transfer, a former mutual business is able to reduce taxable profits or create allowable losses in that way. That is the purpose of the Bill.
Amendment No. 172 would allow the former mutual company, or one that has transferred from a former mutual business, to reduce taxable profits or to create allowable losses for various categories of business, most importantly pensions business, by paying bonuses or expenses out of a surplus that accrued untaxed in the former mutual. We do not think that that is right. It has been discussed fully with the ABI as part of the consultation, and the ABI urges this Committee to reject amendments Nos. 170 to 183. Given the consultations that have gone on and the consensus that has been reached, I urge the hon. Member for Fareham to do the same.

Mark Hoban: I thank the Economic Secretary for his comments. I understand why the Government want to clamp down on mutuals using surpluses to avoid tax, and it is important that that is borne in mind. However, there is a degree of asymmetry in the measure on which the Government might think further as part of the consultation process. In light of the Economic Secretary’s remarks, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Mark Hoban: I beg to move amendment No. 173,page 33, line 18 [Vol II], leave out paragraph 7.

Edward O'Hara: With this it will be convenient to discuss the following amendments: No. 179, page 33, line 40 [Vol II], at end insert—
‘(3A) Where the line 51 amount for the straddling period is greater than the line 51 amount for any subsequent period, and the line 51 amount is then increased in a period following that subsequent period, the adjustment produced by subsection (3) above shall be reduced by an amount equal to the lower of:
(a) the difference between the line 51 amount for the straddling period and the line 51 amount for the current period of account; and
(b) the line 51 amount for the current period of account, and the line 51 amount for the immediately preceding period,
but the amount computed under this subsection shall be reduced by the total sum of adjustments made in periods prior to the current period of account under this subsection.'.
No. 174, page 34, line 39 [Vol II], at end insert—
‘(12) Where this section applies then the company may make a claim requiring that a loss arising under section 436, 439B and sections 441 ICTA 1988 be set off against profits of the same description arising in the proceeding accounting period.'.
No. 180, page 35, line 9 [Vol II], leave out ‘to' and insert ‘from'.
Government amendment No. 195
No. 183, page 35, line 16 [Vol II], leave out from beginning to end of line 19 and insert—
‘(b) the line 51 amount of the transfer or in respect of the business transferred to the company, as computed in the transferor's periodic return.'.
No. 181, page 35, line 41 [Vol II], leave out ‘to' and insert ‘from'.
Government amendment No. 196
No. 182, page 35, line 43 [Vol II], leave out ‘to' and insert ‘from'.
Government amendment No. 197
No. 176, page 37, line 1 [Vol II], leave out ‘two-thirds' and insert ‘one-sixth'.
No. 177, page 37, line 5 [Vol II], leave out ‘one-third' and insert ‘one-sixth'.
No. 178, page 37, line 6 [Vol II], leave out ‘period' and insert ‘five periods'.

Mark Hoban: Perhaps I can commence by making some general remarks on this long series of amendments, and on what paragraph 7, which they seek to amend, is trying to achieve. The taxation of life assurance companies is driven not so much by their accounting profit as by their regulatory returns. We also need to remember the issues that arise from the investment gains of life assurance companies. Paragraph 7 addresses those two issues. Prior to 2004, many life assurers established resilience reserves so that there could be some comfort that the life assurer would have the funds available to pay policyholder claims should there be a negative movement in the investment markets. Those reserves were referred to in line 51 of the regulatory return and were treated as tax deductible.
In 2004, the reserves were replaced with a Financial Services Authority requirement to hold an additional amount of resilience capital in the long-term fund of the life assurer. Those capital requirements were in addition to the usual solvency capital requirements of life assurers. Many life assurers then had to release their resilience reserves, which created taxable income.
There is a second aspect to the issue, which relates to line 51 and the reserves that life assurance companies maintain. Life assurance companies can elect to hold their investments at cost rather than at market value if market value is greater. The combination of such elections throughout their portfolio of investments is often referred to as an investment reserve. Such reserves are usually maintained as a prudent measure to protect against downturns in equity markets. Life assurance companies are about long-term investments, so assurers will often seek to smooth increases in equity markets over a long period to give a better indication of their performance. That is entirely appropriate and acceptable under UK accounting laws. It particularly applies to with-profits business, in which investment reserves are held to smooth the performance of policies for a long period and to reduce the variability between good and bad years.
Following the release of resilience reserves, many life assurance companies sought to increase their investment reserves or to establish new ones. In effect, the taxable income that they would get from the release of the resilience reserve would be offset by the deduction they would receive by setting up a new or enhanced investment reserve, so there would be no tax effect across the business as a whole.
When the life assurance companies discussed the matter with the Treasury—discussions that predate the September 2005 announcement of the then Economic Secretary—they believed that the establishment of the new investment reserves, which replaced the resilience reserves, would be tax deductible. However, HMRC clarified the position on 29 September 2005 when it announced that the investment reserves would cease to be tax deductible from that day. That decision caused significant concerns in the life assurance sector. Legal and General issued a profits warning on 5 October 2005 suggesting that its profits would be hit by £500 million, which is a significant and material item.
There were then further discussions between HMRC, the ABI and the industry. The outcome was a consensus reflected in paragraph 7 of schedule 11. There are three key elements to highlight. The measure now applies only to companies that have no or minimal with-profits business. It applies only to increases in reserves since 2003, and the tax on the recipients’ element of the investment reserves would be spread over the years until 2008. That gives the general background to the amendments.
Amendment No. 173 would delete paragraph 7 in its entirety. The point that I want the Minister to respond to is on the distinction between mergers and the consensus being reached with the ABI. In effect, as I understand it, paragraph 7 will enable investment reserves for non-profit businesses to be taxed, but only where the company is a non-profit business—it does not have much with-profits business. A life assurance company that has with-profits business can establish an investment reserve equal to its resilience reserve and not pay tax on it, whereas a non-profit company cannot do so. It would therefore appear that a non-profit company writing the same type of business as a with-profit company could have a higher tax charge on the same non-profit business. That is the thrust of amendment No. 173, which seeks an understanding of why businesses with non-profit business can be taxed in a different way from those with with-profits business.
Amendment No. 179 is more complicated. It considers changes that may have taken place in the investment reserves since 2003. A key part of paragraph 7 is that it considers only changes in the investment reserve, or line 51 amount, since 2003. The provisions mean that, when there is an existing line 51 amount—the investment reserve—and a reduction in that amount, there should be no tax relief for that deduction. That appears to be reasonable as the intention of new sections 83YA and 83YB to the Finance Act 1989 are to set the line 51 amounts in 2005 in stone.
However, the way that the legislation works at present is that if there is a subsequent increase in the investment reserve due to, for example, a year of strong equity performance when the insurance company seeks to smooth its returns and still has to retain its resilience capital against that, the entire increase in the line 51 amount will be taxable, including the element between the opening line 51 amount at the start of the period and the line 51 amount during the straddling period, even though no tax relief was obtained when the reserve was reduced. That seems to cause a gap in that it does not enable life insurance companies that reduce their investment reserve to have tax relief. However, when they increase their investment reserve, there is a tax charge.
I will give a numerical example to help to clarify the point for the Committee. If a non-profit companyhad a form 14, line 51 investment reserve of £100 at31 December 2003 and that reserve was reduced to £20 in 2006, no relief would be given for the reduction of £80 in 2005. However, if there was an increase in investment reserve to £200 in 2006 from £20, the increase of £180 would be taxed even though the reduction of £80 had not qualified for tax deduction originally. That would appear to be unfair and I should be grateful if the Economic Secretary would look at the matter and comment on it when he responds to the debate.

Rob Marris: Will the hon. Gentleman remind me what a straddling period is? I cannot find the term in the amendment or the Bill but it may be in the Act that the Bill amends.

Mark Hoban: It is not a very elegant expression and the lawyers among us may come up with a better description. It refers to the gap that arises between when the investment reserve was set in stone and its subsequent changes. This is a probing amendment, but if the Government were minded to accept it, the Treasury draftsmen might come up with more elegant phraseology.
Amendment No. 174 considers the way in which the losses on various non-BLAGAB businesses can be used. Section 436 refers to pension business; section 439B to life reinsurance business; and section 441 to overseas life assurance businesses as reasons to establish whether there can be more flexibility in offsetting losses arising on those business streams and especially where there may be an exceptional shareholder profit due to the implementation of section 83YA.
I refer now to amendments Nos. 180 to 182 and Government amendments Nos. 195 to 197. Our amendments would leave out “to” and insert “from”, while the Government amendments would leave out “to” and insert “by”. We are happy to accept the Government’s amendments because they would clarify the issues in respect of shareholder loans. I shall not dwell on amendment No. 183. It is very technical and concerns the value to which assets are transferred between businesses and what their appropriate value should be. There may be some tax planning opportunities for the industry if the amendment were not accepted.
Amendments Nos. 176, 177 and 179 would spread the release of the resilience reserve. The change in temporary practice under schedule 15 on page 78 of volume 11 of the Bill has led to the tax implications being spread over six years. However, under schedule 11, the policy change in tax implications is spread out only over three years. Why are the Government seeking to do that over three years instead of six years, which seems to be the norm in respect of taxation impacts of changes in policy? The amendments are technical, but I hope that they give the Committee a flavour of the issues to which I have referred.

Edward Balls: I will take advice from experts on the precise legal meaning of “straddling period” in due course although, in parliamentary terms, I tend to think that it means the gap that we have to straddle between hearing a question and reaching the point of understanding the answer. However, I doubt that that is an accepted tax definition.
I turn to the amendments that cover paragraph 7 of schedule 11. I am sure that it would help the Committee if I explain why we have reached such a stage and deal with some of the points made by the hon. Member for Fareham. He referred to the issues dealt with under paragraph 7. They were announced originally in September last year to protect the tax base when investment profits are not recognised by a non-with-profits company. As the hon. Gentleman said, proposed section 83YA was initially controversial when it was first announced last September. Its purpose was to prevent companies that had no with-profits business from deferring tax for lengthy periods by not recognising gains on their assets. It is a difficult area of tax. There is a complex set of relationships between different types of life insurance business and the use of reserves to support them.
However, as for why we need a distinction between profits and non-profit companies, in general business with a not with-profit business does not require the smoothing of investment return for tax purposes that is available in with-profits business through the use of so-called book-value election. Non-profit companies do not need to have excess assets and do not need to have profits set aside tax free to achieve their business aims, and until very recently none did. However, in 2004 in particular, some companies that had never used the election before began to do so and the amount of income equal to the amount of the election, which in some cases was in the tens of millions, was escaping tax—possibly for ever.
The actions of the few companies that in 2004 adopted the practice of creating reserves to defer gains were a pure raid on the Exchequer, because the gains that are not brought into account for tax as a result would never be taxed if the section 83YA measures were not put in place. The counteraction in schedule 11 ensures that the few companies that have started to do that do not get an advantage over their competitors arising solely from tax saving. The measure that was announced prevents this deferral of tax and treats the company as if it had not made the election.
The measure initially had a wider impact than intended, because some companies that write both with-profits and non-profit businesses may agree with the regulator to maintain some reserves in their non-profit funds to support the solvency of the with-profits fund should the need arise. When the section 83YA draft legislation was published in September, it was in that type of case that the unintended impact arose. Following representations, these cases were removed from the scope of the legislation in my predecessor’s announcement of 4 November, which ensured that the measure was focused on the targeted avoidance—the use of the book value election where there was no with-profits business that needed supporting. Following that announcement, some companies that had initially considered themselves affected confirmed that they were not.
After the 4 November announcement, there was continuing consultation to ensure that the legislation worked appropriately in all circumstances. The hon. Member for Fareham raised one of the issues put to HMRC concerning the spreading of adjustments where a company had what is called a “resilience capital amount”. After full consultation, the agreement reached with the industry was that it was appropriate that there should be some spreading and that the spread amounts would not be brought back into tax until 2007 at the earliest. The result of the agreements, to which the hon. Gentleman referred, is in paragraph 7 of schedule 11, which represents the agreed outcome of the discussions.
At a major conference on life assurance taxation a few weeks ago, the head of tax at ABI said, in commending the way in which the consultations have gone on and regular meetings have occurred, that
“this approach has already resulted in benefits in the form of better draft legislation for the taxation of investment reserves.”
I am told that “investment reserves” is industry jargon for section 83YA and probably HMRC jargon for legislation that was introduced at that time.

Mark Hoban: Will the Economic Secretary explain why HMRC did not adopt the practice set out in schedule 15 of spreading the adjustment over six years and why it opted for three years?

Edward Balls: I will come to that point in a moment when I speak to the amendments that the hon. Gentleman has tabled, some of which would change the length of the period in question. Before I do so, let me just say that although we fully appreciate that these are probing amendments, we have had an extensive consultation, which the ABI recognises, and it urges us to reflect that in the legislation rather than accept the amendments. However, I shall answer his question in the spirit in which the amendments were put.
Amendment No. 173 would leave out the paragraph that tackles the avoidance problem. As was set out in the Red Book, the cost to the Exchequer of doing so would be £150 million in 2006-07 and £85 milliona year after that. Obviously, we will reject the amendment, because it would do away with the intent to tackle the avoidance problem, which, as I said in my opening remarks on these clauses, was recognised by Opposition Members when these issues were discussed last year. The other amendments in the group would apply if amendment No. 173 was rejected, because if it were accepted, all the following amendments would be moot.
Amendment No. 174 is slightly unusual. It would allow a company affected by new section 83YA to carry back any loss on its pensions business to the previous period. No other company in similar circumstances would be allowed to do that. We urge the Committee to reject that amendment because we cannot see any justification for giving a wholly unconnected relief to a company just because it happens to be a company to which paragraph 7 applies and when companies not in that position would not be allowed that flexibility.
Amendments Nos. 176 to 178 change the spreading mechanism in paragraph 7, which applies where a company had a resilience capital amount for 2005. In a case where that happens the charge under the paragraph is reduced by that amount. That reduction was asked for by industry because it was under the impression that HMRC had agreed that companies could reduce their profits in that way. However, it cannot be right to allow that amount to escape tax for ever. Therefore, the Bill contains a provision bringing it back into tax at a later date. Again, at the industry's request, we delayed the tax charge until 2007 and allowed one third of it to be introduced in 2008.
The amendment would spread that period beyond 2008 to 2012. While it is true that a six-year spread is sometimes allowed when there is a transition from one basis of accounting to another, it is also true that other periods apply—three years, 10 years or no spread at all. A three-year deferral, brought in the last two years of that period, is a sufficiently generous provision. That was agreed with the ABI, as its briefing note makes clear. I hope that I have clarified the position for the hon. Member for Fareham.
The hon. Gentleman gave us a numerical example of amendment No. 179. He proved to the Committee that the proposal is complicated. It proposes a complicated mechanism that appears to be capping the charge to tax in a particular set of circumstances. The matter was discussed in detail with the industry and HMRC officials, whose view was that it was far too complicated to deal with, in what was only a theoretical case. Industry representatives agreed that the matter should be parked for the moment. That is not to say that it cannot be raised and discussed in the ongoing consultation, to which I referred earlier. The circumstances in which the amendment would operate cannot apply in 2005 and are unlikely to apply in 2006. If it turns out that there is a real and substantial problem in later years, we can consider the points that have been made.
Amendments Nos. 180 to 182 change “to” to “from” as the hon. Member for Fareham explained. Both he and the Government noted that the word “to” was wrong, but changing it to “from” would cause complications. Government amendments Nos. 195 to 197 achieve the same purpose, but follow our iterative consultation with clarity.
Amendment No. 183 allows an adjustment to be made where a company acquires business from another insurer. Paragraph 7 allows that adjustment where a company has made an election under a provision in the Income and Corporation Taxes Act 1988. That is because that election will only be relevant where a company is one to which paragraph 7 might apply. The amendment would allow a company that forgot to make the election to still benefit from the adjustment. That was discussed with industry before the Bill and the general view seemed to be, as the ABI briefing note makes clear, that the amendment was not appropriate.
With the exception of the Government amendments which correct a drafting problem, we ask the Committee to reject the remaining amendments. I hope that, in the spirit in which they were tabled, my remarks have clarified some of the matters for Opposition Members.

Mark Hoban: I am grateful to the Economic Secretary for his response to the amendments. The area is not as straightforward an area of legislation as the discussions between the HMRC and the ABI suggested. The announcement in December 2005 caused great consternation among life insurers. It has taken some time and discussion to reach a settled position with the ABI on the matter. Sadly, debates such as this cannot do justice to the complexity of the issues, but they demonstrate the complexity of industry issues in specialist areas and the need for proper consultation and debate. I hope that the debate on schedule 11 and the preceding discussions with industry will ensure that we think carefully about how the consultation document is implemented in future legislation. The interaction with regulatory terms, resilience reserves and such things demonstrates that a broad consensus is needed on such issues to ensure that problems do not recur.
Given the importance of life insurance companies in our economy, springing changes upon them that lead major companies to issue profit warnings is perhaps not the most satisfactory way to proceed. We recognise and accept the consultation process that led to paragraph 7. On that basis, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Amendments made: No. 195, in page 35, line 9[Vol II], leave out ‘to' and insert 'by'.
No. 196, in page 35, line 41 [Vol II], leave out 'to' and insert 'by'.
No. 197, in page 35, line 43 [Vol II], leave out 'to' and insert 'by'.—[Ed Balls.]

Question proposed, That the schedule, as amended, be the Eleventh schedule to the Bill.

Rob Marris: I welcome you to the Chair, Mr. O’Hara. I declare an interest as a policyholder in Standard Life, one of the 32,000-odd, or less than 10 per cent., that voted against demutualisation recently. Sadly, we lost by more than 90 per cent.
I refer my hon. Friend to paragraph 5 of schedule 11, which deals with surpluses of mutual and former mutual businesses. Can he give a little bit of background on the taxation situation between mutual and non-mutual life insurance companies? I am concerned that we as a Labour Government might be creating a tax regime that encourages organisations to demutualise. If that is the case, it would be most regrettable. Our tax regime should discourage organisations from demutualisation. It should gently encourage organisations to remain mutual, not put them in a cast-iron straitjacket.
The provisions understandably discuss taxation where there is demutualisation and a kind of locked-up surplus that has been hidden, in an accounting and not a legalistic sense, and then comes out of the woodwork so as to avoid tax. What would the position be if it were the other way around? I appreciate that it is perhaps not a very likely possibility, but one remains an optimist as a Labour Back-Bench Member that life insurance companies might decide to mutualise. What would the tax situation be with any surpluses or non-surpluses? Will my hon. Friend say a little bit about the background of the taxation of mutuals vis-Ã -vis non-mutuals?

Mark Hoban: A straddling period.

Edward Balls: If I wanted to, I could read out to hon. Members opposite the precise definition of a straddling period, but I choose not to do so. I shall move on to the substance of what my hon. Friend the Member for Wolverhampton, South-West (Rob Marris) said. The decision as to whether companies should be mutual or demutualised is a matter for individual companies. I have some sympathy with the points that he makes. As a Co-operative as well as Labour Member of Parliament, I believe that mutuals have an important role to play. The mutual sector and the third sector have important parts to play in relation to my wider responsibilities for financial capabilities and financial inclusion.
As part of the follow-up to the issues that arose on equitables, Paul Myners did a review for the Government. That consulted widely, and before I was elected to this House I was involved in those consultations. In order that we understand the role that mutuals can play in the financial services industry, and the great strengths that they can bring to certain aspects of business, I am going to meet with Mr. Myners to assess his view of progress since the publication of his report. I assure the Committee that I shall take the matter very seriously.
More broadly, our aim in this legislation is to ensure that the tax system is neutral between being a mutual and demutualising. Some concern has been expressed from the other side that, by tackling an avoidance problem, the legislation was creating potential barriers to demutualisation. My hon. Friend the Member for Wolverhampton, South-West will probably applaud, but others might not. The Government’s view is that it should be a matter for individual companies. Any company that has created an exception surplus while mutual will be no worse off should it demutualise than it would have been had it never created a surplus. There is no down side in the shape of unexpected tax changes, but the tax advantage at the time of demutualisation will be gone. I hope that that reassures him that we are neither erecting a barrier to demutualisation nor allowing the continuation of an incentive to demutualise. I would therefore encourage him to pursue the wider discussions that we would like to have about the role that mutuals can play in the delivery of financial services and the Government’s wider agenda—but at another time; not during this stand part debate.

Question put and agreed to.

Schedule 11, as amended, agreed to.

Clauses 87 and 88 ordered to stand part of the Bill.

Schedule 12

Settlements: Amendment of TCGA 1992 etc

Theresa Villiers: I beg to move amendment No. 198, in schedule 12, page 41, line 45 [Vol II], leave out paragraph 2.
Before turning to the substance of the amendment, it might be useful to make some general points on schedules 12 and 13. The aim of the schedules, as I understand it, is to introduce more consistency in the income and capital gains tax treatment of trusts. The goal of making the tax treatment of trusts more consistent and transparent is certainly sensible. However, the modernisation of trusts project, from which the provisions originally flowed, sought to secure more consistency between the income tax and capital gains tax treatment of assets held on trust and those held outright. It is a desirable goal that trusts should not confer tax advantages, but nor should they suffer a fiscal penalty. As we shall see in the debate on schedule 20, that principle seems to have been abandoned.
Schedule 20 has an impact on our discussions on schedule 12 also because the modernisation of trusts project was subject to a lengthy consultation with the professional bodies on the income tax and capital gains tax proposals and ideas. A serious concern is that the consultation on the taxes took place without any indication that the Government were planning the significant changes to the inheritance tax regime that are proposed in schedule 20. It is difficult to view the capital gains tax and income tax changes set out in clauses 88 and 89 in isolation from the inheritance tax charges in schedule 20, and it is therefore unfortunate that the lengthy consultation process took place without those involved being able to examine the three taxes in the round. The regimes governing the three taxes overlap and problems may arise if they are not all considered together, some of which I shall outline this afternoon.
It makes sense to examine the tax regime for trusts holistically. There are good arguments, as we shall see when discussing schedule 20, for postponing the implementation of clauses 88 and 89 until there has been a full consultation and discussion of how the provisions interact with one another. That point was well made by the Chartered Institute of Taxation in its briefing on the Bill, in which it stated:
“Given that the Tax Law Rewrite Bill covering settlements provisions is currently in progress, and parts of the trust modernisation project remain outstanding (eg income tax streaming and tax pools), it seems even more compelling that implementation of this legislation be postponed until 6th April 2007, so that a single comprehensive and comprehensible corpus is enacted.”
Amendment No. 198 would delete paragraph 2 of schedule 12, which is intended to repeal sections 69(1) and 69(2) of the Taxation of Chargeable GainsAct 1992. Section 69(2) of that Act provides that UK-based trustee companies can opt to be treated as being resident overseas for capital gains tax purposes if they are dealing with a trust set up by a person who has no connection with the UK tax system; that is, if the settlor is not domiciled or resident in the UK and is not subject to UK taxes. The residence of trustees is important because their residence determines where a trust is deemed to be resident and therefore which is the applicable tax jurisdiction. Section 69(2) allows trustees to attract business from foreign clients without bringing the tax affairs into the UK tax system. It was intended to enable UK-based trustee companies such as banks to compete in the market for the overseas trust business. That approach is echoed in other jurisdictions, such as New Zealand and Canada, with the intention of ensuring the competitiveness of their locally based professionals.
I gather that the matter was pressed strongly by the professional bodies during the consultation; they actually wanted the exemption to be extended to cover income tax as well as capital gains tax. During the consultation it seemed to be assumed that the section 69 exemption would continue into the new regime. There were indications that the Government might even be sympathetic to extending it, which seemed to have been contemplated in earlier consultation papers and in draft legislation published by the Government, such as the documentation accompanying last year’s pre-Budget report. I have received a number of representations from those who are concerned about the change that eventually appeared in the Bill.
The Government may have been motivated by the anxiety that section 69(2) of the 1992 Act might have breached European law. Will the Paymaster General confirm whether that was indeed a concern? If so, will she share with the Committee the legal opinions on which that concern was based? I am sure that there are all sorts of rules that would entitle the Government to withhold the legal advice if they wished but if that is a concern it would be useful for the Government to share some of the legal advice that they have received. Even if it is the case, moreover, some form of amendment would still be welcomed by the affected professionals.
Professional practitioners have also questioned whether it would be possible to apply an exemption. The Chartered Institute of Taxation has said that
“The benefit to the UK economy of retaining global trust business in the UK could still be achieved, it seems to us, by the simple expedient of amending the original draft clauses so that the trustees’ residence requirement were enlarged from the UK to the rest of the European Union.
Any person resident there could act as professional trustees with the same tax consequences.”
They go on to say
“This was one area where the representative bodies felt very strongly in favour at the consultations.”
I should be grateful for the Paymaster General comments on that.
The Institute’s solution has considerable appeal and seems to deal with any anxiety that may exist regarding the impact of the clause on EU law. I cannot imagine that retaining section 69(2) is likely to have a negative revenue consequence, because the settlors and trusts in issue are not subject to UK tax. Deleting section 69(2) would have a negative impact on revenue, however, because the fees earned from international trust business would be lost to UK firms and would no longer be available for taxation. I hope that the Government will therefore reconsider deletion given its potential negative impact on the competitiveness of the professional service industry—an industry that plays an important part in maintaining invisible exports and a healthy British economy.

Rob Marris: The hon. Lady mentions the Chartered Institute of Taxation and a change from the UK to the European Union. Where would that leave places such as the Isle of Man, Guernsey, the Canary islands and Gibraltar, given their different tax regimes? Would that not be a problem?

Theresa Villiers: I have to confess that I do not know the answer to that because I have only considered trust companies based in the UK, but I do not think that the amendment would have any impact on those jurisdictions, as they have their own rules. The Paymaster General may be able to answer more effectively, but the amendment relates purely to UK companies and companies based in the rest of the EU, and my understanding is that it would not have any impact on such offshore jurisdictions.

Dawn Primarolo: I am always grateful when the hon. Lady explains what my clauses do, because it means that I do not have to. It shows how well they are drafted.
The amendment would leave intact the capital gains tax residence test for trustees, including professional trustees, whereas the test would otherwise be replaced by the new residence rule in schedule 12. I have sympathy with the motives behind the amendment but, as I shall explain, I cannot support it. Schedule 12 makes several changes to capital gains tax legislation for trusts and mirrors the changes to the income tax regime that were introduced in clause 89 and schedule 13.
At present, trustees have to grapple with two quite different sets of rules that determine trustee residence for income tax and capital gains tax purposes. Some trustees are resident in the UK for income tax purposes, but are non-resident for capital gains tax purposes, and vice versa. Schedules 12 and 13 introduce a new, common residence test for trustees, both for income and capital gains tax purposes. The test has been widely consulted upon as part of the trust modernisation package, and has been broadly welcomed as being clearer and easier to apply than the current capital gains tax test, particularly for smaller trusts. However, the proposed residence test does not include an equivalent to the current capital gains tax rules on the residence of professional trustees. As the hon. Lady mentioned, Her Majesty’s Revenue and Customs received representations that the special rule should be retained to enable UK professional trustees to continue to attract businesses administering foreign trusts.
In response to those representations, HMRC included new rules on professional trustee’s residence in the draft legislation published in January 2006. However, those new rules that resulted from consultation were published with a strong warning that they might be withdrawn if they were found to be a state aid. I think that the hon. Lady knows perfectly well what that would mean; she was a Member of the European Parliament and I have debated with her in that forum the concept of unfair tax and state aid rules.
Shortly after publication, the Department of Trade and Industry advised HMRC that the new test would constitute state aid—it would have been unfair competition against professional trustees in other European states—and that there were no grounds on which the European Commission would approve the proposed measure as a state aid. Based on that advice, the Department withdrew the proposals covering professional trustees, and it would be inappropriate therefore to retain the existing capital gains tax rule.
The hon. Lady asked if I would like to share that legal advice. The answer is that I would not like to share that with her, the Committee, or anyone else. That was advice to the Government, and to do so would be to breach a fundamental legal and professional privilege, which is a matter that Opposition Members go on about at some length. The Government are entitled to do the same.
I can assure the Committee that the new residence rule still allows professional trustees to attract business to the UK in largely the same way as did the old rule. The only difference is that the trust will need to have one non-resident trustee. Given that the vast majority of professional firms have reciprocal arrangements with overseas firms, all non-residents setting up a trust in the UK can appoint a non-resident friend or relative as a trustee. Frankly, I do not see that that will cause practical problems as some have feared, and under the circumstances I hope that the hon. Lady will withdraw her amendment. However, if she decides to push it to a vote, I will urge my hon. Friends to oppose her.

Theresa Villiers: I am grateful to the Paymaster General for her comments. I shall not press my amendment to a Division, but I shall mention one or two matters in response to her remarks.
I understand that the Paymaster General is entitled to keep the Government’s legal advice confidential should they so wish, but it would have been a productive addition to the debate. Given the clear advice it seems that she has received from the Commission, I can understand that maintaining section 69(2) in its current form would create problems. 
I press the Minister on whether any consideration or thought was given to the idea that the Chartered Institute of Taxation put forward of giving the same treatment to companies based in the UK as to those based in the rest of the European Union. Would that be feasible? It seems to me to meet all the concerns of the professionals without breaching the state aid rules.
The right hon. Lady explained that the consequence of the measure would simply be the appointment of one non-resident trustee. I acknowledge that that would be one of the key impacts of the loss of section 69(2). However, I am informed that that would lead to significant additional cost implications. We must bear in mind that the UK is a popular jurisdiction for offshore, overseas trust business because we are known as an entirely respectable jurisdiction. The necessity of adding a Swiss trustee, or one from another jurisdiction, will add costs to our trustee companies and undermine competitiveness. As I said, provisions similar to those in section 69(2) are still in operation in other jurisdictions—for example, in Canada and in New Zealand. It is unfortunate to add the extra cost to our professional companies, if there is a way to retain a section 69(2) type provision, so long as that provision is adapted to comply with EU law.
I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Question proposed, That this schedule be the Twelfth schedule to the Bill.

Theresa Villiers: There are a number of important issues about schedule 12 that the Committee should consider. First, as I suggested, one of the goals of the schedule is to harmonise and ensure consistent definitions of trust-related concepts in different pieces of legislation, in particular to harmonise legislation relating to income tax and to capital gains tax. Paragraph 1 of the schedule seeks to insert new sections 68A to C into the Taxation of Chargeable Gains Act 1992. Those provide a new definition of settlor and settlement for the purpose of capital gains tax. Schedule 13 seeks to introduce the same changes to the Income and Corporation Taxes Act 1988 for the purpose of the income tax trust.
However, the unification of the definitions is not complete. For example, in sections 97 and 286 of the Taxation of Chargeable Gains Act 1992, the definitions of settlement found in the Income Tax (Trading and Other Income) Act 2005 are to apply, whereas the settlor will have its new Finance Bill meaning. So there is a degree of unification of the definitions but that unification is not complete.
More seriously, a number of problems arise relating to the new definitions proposed in paragraph 1(2) of schedule 12. Given the changes to the definition of settlor interested trusts, which are set out in paragraphs 3 and 4 of the schedule and to which I will turn in due course, there is an urgent need for clarification of the issues relating to the definitions. They will have a significant impact on a number of trusts. There is some guidance in the explanatory notes but any further reassurance that the Paymaster General can give the Committee on how the new definitions will operate will be welcomed by the people affected.
New section 68A sets out the definition of “settlor” but it seems to pay insufficient regard to situations in which there is more than one settlor. Such cases can be common—for example, where husbands and wives set up trusts together. Given the provisions as drafted, it will not always be easy to work out who the settlor is. In many cases, it may be difficult to determine when someone ceases to be a settlor.
The first point on which I would be grateful for clarification relates to the meaning of “made the settlement”, which appears a number of times in new section 68A. The Chartered Institution of Taxation indicates that there is need for clarification on the situation when a person who is not the original settlor adds property to an existing settlement. Does she create a settlement or become settlor of the existing one? That is a matter of particular importance when one takes into account the changes made by paragraphs 3 and 4 of the schedule.
Another concern relates to subsection (6) of the new section 68A, which governs the issue of what happens when someone ceases to be a settlor. The Institute of Chartered Accountants highlights concerns about the words in subsection (6)(a) which provide that someone ceases to be a settlor if
“no property of which he is a settlor is comprised in the settlement”.
That may sound simple enough, but a complication can arise when more than one settlor has transferred property into the trust and when there is a mixed fund of property contributed by different settlors. For example, the original property may have been sold, new investments may have been bought and the original investments donated to the trust may have been sold and the proceeds transferred into new investments. It then becomes rather more difficult to distinguish which asset is which in terms of the settlor who donated it to the trust. The provisions in the Bill are not clear about deciding in that situation how the question whether someone has ceased to be a settlor is to be answered.

Rob Marris: In respect of subsection (6)(a), if the hon. Lady is talking about property that has been sold and churned around, if I may put it in that way, is it not straightforward that the standard legal procedures of tracing would be used?

Theresa Villiers: That probably makes sense as there is an available set of rules that could be used in this context. The explanatory notes seem to suggest that a proportionate approach is taken, but I agree that the rules on equitable tracing could be applicable in this respect and for clarification it would be useful if the Minister could indicate whether that would be the case.
The same issue arises in relation to the rules for transferring property. In order to answer the questions about where property is transferred between settlements it is crucial to know whether the relevant people remain settlors of the old settlements, whether they have become settlors of the new one or if they are settlors of both settlements. Again, there is the issue of whether there should be a proportionate approach to this type of transfer or whether, as the hon. Member for Wolverhampton, South-West suggested, we should take a more sophisticated approach and rely on the rules in respect of equitable tracing.
There is some difficulty in relying on a simple, proportionate approach because that might mean that where property that is identifiably and obviously from one original trust or settlor is transferred, it seems unfair to taint all the other settlors of the original trust with that transfer. There is a good case for dispensing with the proportionate approach and opting for a more sophisticated one in terms of identifying and apportioning the transfers made.
That is important because of the changes introduced in paragraphs 3 and 4 of schedule 12, which dramatically increase the scope of trusts that are deemed to be settlor-interested and thus denied holdover relief. The identity of the settlor therefore becomes even more crucial as a result of the operation of those paragraphs. My understanding is that all the professional bodies such as the Society of Trust and Estate Practitioners, the Institute of Chartered Accountants and the Chartered Institute of Taxation have protested about the impact of paragraphs 3 and 4, which in their view extend the definition of settlor-interested trusts much too widely. The effect of the changes proposed in new subsection (2A) of section 77 of the Taxation of Chargeable Gains Act 1992 will be that the trusts set up by parents for children under 18 will automatically be treated as settlor-interested trusts. As a consequence, capital gains relating to the trust property are treated as though they are gains made by the settlor and are taxed accordingly. As the Institute of Chartered Accountants points out, it is difficult to understand why the new provisions are needed in the capital gains tax context, as all trust gains are already taxed at 40 per cent. It does not seem to be an avoidance issue that is being tackled.
The trust rate could be higher than the settlor’s rate because the trust will not, as I understand it, be entitled to taper relief. The changes proposed to section 77 through new subsection (2A) are supposedly designed to import an income-tax-based rule into the law on CGT and thereby to achieve the consistency that is the overarching goal of the project on the modernisation of trusts. Under income tax rules, there is provision to deem the income of a trust for children to be that of the parent setting up the trust, although the rule bites only if the income is distributed to the child. The new CGT rule goes much further, impacting on all property going into the trust.
The income tax rule was enacted to prevent the settlor from claiming the benefit of his children’s income tax personal allowances. If the Treasury really wanted to implement the same rule in the CGT context and to prevent attempts to use the annual CGT exemptions for child beneficiaries, it could have proposed provisions targeted on distribution of property to the child. That could have been taxed as gains by the parent.

Rob Marris: The hon. Lady has referred to income. One needs to differentiate between income and property, because if we are talking about property, particularly realty, there is a huge difference. One can use the property—live in it—as a minor on whom a settlement has been made. In terms of undistributed income, to which the hon. Lady referred, it is undistributed. The minor has no benefit from it, so there is potentially a big difference.

Theresa Villiers: There is a big difference, but it is still a harsh penalty to deny these trusts holdover relief, which is the impact of paragraphs 3 and 4. Property going into trust no longer has holdover relief. I do not believe that aligning the income tax and CGT rules requires denial of holdover relief for property going into the trust, but that seems to be the result of the changes in paragraphs 3 and 4. As I am sure the Committee is aware, where holdover relief applies, the gain on the asset is held over to the point at which the CGT is applied.
The professional groups have expressed their serious concern about the removal of holdover relief in this context. The Institute of Chartered Accountants points out some of the undesirable anomalies that the new rules seem to produce. For example, the transfer of the same property to be held by trustees as bare trustees for a child under the age of 18 would be eligible for holdover relief, as would a transfer to a non-bare trust for the benefit of children over 18. However, a transfer to a non-bare trust for under-18s does not attract holdover relief. The ICA states with some justification:
“There seems no purpose in creating this bizarre discontinuity and we request that it is removed from the Bill.”
It describes the change as “particularly unwelcome and illogical”.
As well as creating that anomalous result, the denial of holdover relief conflicts with well established tax law principles. Generally, if a disposal attracts inheritance tax, it will not be subject to capital gains tax. Historically, CGT holdover relief has therefore been available where inheritance tax is levied. In the case of trusts for minors, it seems that schedule 20 of the Bill will apply IHT and schedule 12 will apply CGT without holdover relief. Thus, unless either schedule 12 or schedule 20 is amended, CGT and IHT will both bite on the same transfer.
The Treasury seemed to be unaware that schedule 12 would have that effect when it stated in Budget note 25 that assets settled in trust for minors would qualify for holdover relief because they were now chargeable transfers for IHT purposes.
Further complications arise where a parent makes a contribution to a trust that was set up by someone else for children under 18 years old. That is where the rules on transfers between and into settlements become important, which is why Iasked for clarification at the start of the discussion. For example, a parent might pay professional fees or add money to the trust to meet a particular expense, and it seems that under the new rules that is enough to make the trust settlor-interested, merely because a parent who was not the original settlor writes a cheque for a trust expense as a matter of administrative convenience. The original settlor might know nothing about it and might be completely unaware that it has happened.
Section 169C(2)(a) of the Taxation of Chargeable Gains Act 1992 denies holdover relief so long as the clawback occurs, dating back to when the property is paid in. That applies so long as any settlor is settlor-interested for the purposes of section 169C. Hence, even if the original settlor is not a parent and is unaware that the arrangement has been made, the whole trust becomes settlor-interested as a result of the parent’s involvement in paying a trust expense. The whole trust becomes tainted. If that interpretation is wrong, I should be grateful to the Paymaster General for pointing out how, because it is a real anxiety.
The loss of holdover relief seems a harsh penalty to impose merely because someone pays some professional fees, and I should be grateful if the Paymaster General would therefore give the Committee some further explanation of the rationale behind paragraphs 3 and 4, particularly on the issue of contributions to the settlement by an external person who happens to be a parent.
Paragraph 6 deals with sub-fund settlements. It will introduce a new schedule 4ZA to the TCGA 1992 which will contain a provision allowing trustees to elect that sub-funds be treated as a separate settlement. In principle, such a change is welcome, because breaking up a trust into sub-funds can enable more efficient management, and many larger trusts already use that device. In the past, a degree of uncertainty and complication has arisen due to sub-funds being treated as part of the overall settlement for some CGT purposes but separately for others, and because of variations between the CGT and income tax rules.
However, professionals such as the Society of Trust and Estate Practitioners and others to which I have referred have pointed out a problem with the operation of the new provisions. The Institute of Chartered Accountants believes that the provision will not be used in practice because the consequence of electing that a sub-fund be treated as a separate settlement is that there is a deemed disposal and a CGT charge. The savings to be made in administration costs for setting up a sub-fund are unlikely to outweigh the additional tax liability of a CGT charge. The professionals point out that the provision will therefore not be used and will have no effect unless holdover relief is granted that deems the property to pass on a no gain, no loss basis. Without that change, this quite complicated provision could effectively end up as a dead letter.
Paragraph 8 of new schedule 4ZA deals with who might be a beneficiary of a sub-fund. It will limit the power to elect to treat sub-funds separately from the main trust. Again, the professionals are critical. The provision provides, with limited exceptions, that a sub-fund election can be made only when there is no beneficiary under the sub-fund who is also a beneficiary under the main settlement.
It is quite difficult to understand the rationale for that restriction, and I should be grateful for the Paymaster General’s views, because I cannot identify a loophole or problem that would be covered by the provision. It would seem further to undermine the usefulness of the sub-fund facility that the Government are seeking to introduce to try to make life easier for trustees and settlors. Particularly in the context of family trusts, there is often some commonality between the beneficiaries of the principal fund and the sub-funds. I hope that the Paymaster General will throw some light on the rationale for that restriction.
Paragraph 12 of new schedule 4ZA on sub-funds concerns information requirements. It sets out the information that must be provided to Revenue and Customs when trustees elect to create a sub-fund. That information includes:
“such information as the Commissioners for Her Majesty’s Revenue and Customs may require in relation to the principal settlement (which may, in particular, include information relating to the trustees, the trusts, property which is or has been comprised in the settlement, the settlors or the beneficiaries)”.
That provision seems very wide indeed, and it is difficult to see how it could be justified in thatcontext. Again, the Institute of Chartered Accountants commented:
“There is a growing tendency to make information provisions much wider than are strictly necessary. There is no reason at all to know about property no longer in the settlement or anything about the settlor or the beneficiaries as these are not relevant factors.”
It could be argued strongly that the information required in paragraph 12 is too broad and should be narrowed.
In conclusion, there are a number of uncertainties in relation to the schedule, on which I would be grateful for clarification from the Paymaster General.

Philip Dunne: I declare my interest as a settlor and investment beneficiary of a trust. I was going to speak at some length to schedule 12, but my hon. Friend the Member for Chipping Barnet has ranged widely and comprehensively over all the issues that I wanted to pick up.
I should like to make one specific observation on paragraph 19 and settlor-interested trusts for minors. Paragraph 96 of the explanatory notes, which covers paragraph 19, seeks to link the provisions to an exemption for disabled dependent children’s trusts set up for disabled children as part of the inheritance tax regime exemptions. Will the Paymaster General clarify whether the statement in the explanatory notes means that trusts covering disabled children will be exempt from the capital gains tax regime? It is not apparent in the drafting of paragraph 19 that it covers the disabled exemption; it appears to cover all minors rather than merely those who are disabled.
My hon. Friend made a telling point: the measures seek to impose capital gains tax charges on assets put into trusts for minors. That has the potential to create double taxation on such trusts, not to deal with an avoidance problem, but to provide belt and braces for the Government in generating more revenue.

Dawn Primarolo: I was surprised at some of the comments made by the hon. Members for Ludlow(Mr. Dunne) and for Chipping Barnet. I remind the Committee that consultation on the modernisation of trusts began in December 2003. That has been a very good consultation looking specifically at how the arrangements for trusts could be simplified and, where possible, definitions brought into line. There was considerable discussion on last year’s Finance Bill as well.
The schedule sets out two principal changes to the capital gains tax rules with a number of consequential and minor amendments to provide a better and clearer environment in which trusts can operate. The Government were not motivated by the pursuit of revenue or the need to deal with avoidance, as was suggested. The first change concerns the alterations to capital gains tax definitions affecting the taxation of trusts in such a way as to align them more closely with income tax rules. It is easier to have it that way. It is not possible to align them entirely because of the nature of the two different tax bases—income tax and CGT—but that was the point. There is a common test for the residents of a body of trustees and what constitutes a settlor entrusted trust, to which the special tax rules apply.
The changes are designed to ease the burden for trustees, particularly lay trustees, which hon. Opposition Members are usually keen on. I remember that, during discussions on an earlier part of the Bill, some Opposition Members felt that the Finance Bill should be capable of being read by anybody who cared to pick it up and wondered what it might be saying. Yet now, apparently, they want to swing the other way to respond to complex situations.
The second change, suggested by the trust industry representatives, was the introduction of a facility for trusts to elect a sub-fund of a settlement to be treated for tax purposes as if it were a separate settlement. The opportunity to elect a sub-fund will be particularly useful to trustees of older settlements who do not have the power to set up new settlements—but where trusts within the settlement are administered separately for tax purposes. Taken together, these are positive, good changes.
The hon. Lady asked various questions. I shall deal with those and make a general point at the end. Most of the questions come from those who are motivated to plan rather more complex forms of trust. Her first question concerned the new definition of “settlement”. The term “settlement” applies wherever one has settled a property. It is necessary to retain—not to create—the anti-avoidance definition of “settlement” for the purposes of the legislation in the Income Tax Acts and for certain limited capital gains tax purposes, because it covers a much wider set of circumstances than situations where property is held in trust. As the new definitions are based on current capital gains tax meanings—the key trust-related terms—it should, in future, be easier for trusts to navigate the income tax and capital gains tax regimes.
The hon. Lady then asked about a property in settlement with two or more settlors. The legislation determines the identity of the settlor of the transferred property. If the property cannot be identified as originating from a specific settlor, it is attributed to all settlors in proportion to their relevant contribution to the original trust. In most cases, it should be possible to attribute property that has not been turned into cash by the original settlors.
Whether a settlor ceased to be a settlor of a settlement would depend on the facts of the case. The hon. Lady made a point about what would happen in respect of ceased settlors if there were nothing to show the source of the cash paid in. If there is nothing to show the source of the cash paid out, the reasonable conclusion would be that it came pro rata from all the cash in the trustee’s possession. There is nothing new here.

It being One o’clock, The Chairmanadjourned the Committee without Question put, pursuant to the Standing Order.

Adjourned till this day at half-past Four o’clock.